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MphasiS: Bracing for growth

Jul 9, 2003

MphasiS has announced its 1QFY04 results and has reported a topline growth of 8% and a bottomline growth of 4% sequentially. However, the operating margins for the company have dipped significantly by around 300 basis points. This pressure on margins is because of huge build-up in capacity, both in telecom infrastructure and in people.

Rs m 4QFY03 1QFY04 Change
Sales 1,209 1,302 7.7%
Other Income 18 28 55.6%
Expenditure 1,010 1,127 11.6%
Operating Profit (EBDIT)** 199 175 -11.8%
Operating Profit Margin (%) 16.4% 13.5%  
Interest (5) (8) 39.6%
Depreciation - -  
Profit before Tax 222 211 -5.2%
Extraordinary items 0 0  
Tax 35 16 -54.9%
Profit after Tax/(Loss) 187 195 4.1%
Net profit margin (%) 15.5% 15.0%  
No. of Shares 17.3 34.6  
Diluted Earnings per share* (Rs) 21.6 22.5  
P/E Ratio (x) 17 16  
* annualised
** includes depreciation and amortisation of ESOPs

The highlight of the quarter was the growth in MsourcE’s revenues that have grown by 23% sequentially. This was higher than the 17% growth that MsourcE had recorded, sequentially, in the last quarter of FY03. However, the revenues from the software services’ business showed a sequential growth of 2%. MphasiS is counting on its BPO operations for its growth going forward, and it is seen from the concentration of revenues from MsourcE that is increasing along quarters.

Operating profits of MphasiS have been affected mainly because expenditure has grown at a higher rate than the growth in topline. Expenditure has risen mainly due to rise in the number of employees (both onsite and offshore). MsourcE’s added 533 people in this quarter (463 in 4QFY03). Total staff strength of MsourcE thus has risen to 3,120. MphasiS plans to add 1,400 employees to MsourcE to take the tally to 4,000 employees by the end of FY04. The ramp up has been mainly carried out in expectations of strong growth in business going forward. Another reason for the rise in expenditure has been the setting up of new development centers in Mumbai and Shanghai and a call centre in Mexico. However, a decline of 55% in tax-paid has provided some cushion to the profits in 1QFY04.

On a divisional basis, MphasiS’ (software services) margins have taken a bigger hit in the June quarter. This is despite the fact that the company has been able to maintain its billing rates. This indicates that pressure on margins was mainly a consequence of rise in employee costs. Margins for MsourcE continued to remain negative. However the June quarter witnessed an improvement in margins.

Margins under pressure...
Operating margins* 1QFY03 2QFY03 3QFY03 4QFY03 1QFY04
MphasiS 17.3% 21.0% 24.3% 25.5% 20.5%
MsourcE 6.0% 9.7% -3.0% -10.4% -3.80%
Consolidated 15.5% 18.9% 19.1% 16.4% 13.50%
*includes depreciation

While Indian software majors are witnessing tremendous pressure on the pricing front, MphasiS has been able to maintain its billing rates. This may be on account of the small size of orders that MphasiS gets in comparison to its large Indian counterparts. Also, going forward as bigger contracts flow in, MphasiS may witness higher pressure on billing rates. However, higher growth in volumes could compensate for the decline or stagnation in billing rates.

In 1QFY04, the company added 12 new clients (6 in 4QFY03), including two for MsourcE. Client concentration continues to be a problem for the group. The largest client contributed to around 21% of total revenues in 1QFY04 (up from 19% in 4QFY03). The risk is more prominent for MsourcE where the largest client contributes to around 22% of revenues (23% in 4QFY03). Also, MsourcE continues to derive a high 86% of its revenues from the US region. Another risk for the company is in form of concentration of revenues from the financial services vertical from where it derived around 51% of its revenues. The concentration of revenues form this vertical is even higher for MsourcE (88% in 1QFY04).

At the current market price of Rs 363, the stock is trading at a P/E of 16x its annualized FY04 earnings. The management has projected a 30-35% topline growth, and 40-45% bottomline growth for FY04. Significantly, for the ITES business, the management expects revenues to grow by 100% in FY04. As the group ramps-up its operations by investing heavily in manpower and marketing and distribution infrastructure, margins are likely to be under pressure for the short-term. This is likely to be truer for MsourcE that has been in the red for the past three quarters at the operating levels.

However, considering the strong growth prospects of the ITES industry and the fact that services business (in terms of volumes) is also likely to improve going forward, the company seems to be well placed to capitalize on the same. Having said that, we would also like to point out that, investors need to take the company’s revenue guidance with a pinch of salt. The risk return proposition still remains high.

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